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Key Points for the Week

  • The Federal Reserve raised rates 0.75% to a target range of 2.25-2.50%.
  • U.S. gross domestic product (GDP) declined 0.9%, restrained by falling goods purchases and slower inventory growth.
  • The S&P 500 gained 9.2% in July, its best month since COVID vaccine data was released in November 2020.

Things to Consider While Planning for College

Whether you have a newborn child or a family member about to enroll in college, it is quite likely that the cost of a college degree today and in the future has crossed your mind.

In 2022, the average cost per year for in-state tuition of a 4-year public university is $27,000. The average cost for out-of-state tuition is $44,000. If you are looking for a 4-year private school, the average tuition is even higher. The sticker shock is exacerbated with the knowledge that those average costs are only for tuition and that other costs, such as room and board, books, laptops, personal living expenses, and other miscellaneous costs will crop up throughout the year.

With this in mind, our human-centric team has compiled a guide that you can access here with questions and aspects to consider today and down the road. If you have any questions about the guide or how college planning fits within the scope of your financial plan, please contact us.

Economic Update

Last week, we learned from the Bureau of Economic Analysis (BEA) that economic growth in the United States slowed for the second consecutive quarter. Economic growth is measured by gross domestic product, or GDP, which is the value of all goods and services produced during a specific period. GDP includes household, business and government spending, as well as exports and imports.

Before inflation, the U.S. economy grew by 6.6 percent in the first quarter of 2022 and by 7.9 percent in the second quarter, according to the FRED Economic Data. After inflation, GDP shrank by 1.6 percent in the first quarter and by 0.9 percent in the second quarter.

Is it a recession, or isn’t it?

Two consecutive quarters of negative growth is the popular definition of recession, and there was a lot of debate last week about whether the U.S. is in a recession. One reason for the debate is that the main driver of U.S. economic growth is household spending, which accounts for about 68 percent of GDP. During the first half of the year, household spending continued to increase, although the rate of increase slowed.

While a low unemployment rate and still-healthy consumer and corporate balance sheets mean the economy continues to show resilience for now, expectations that the U.S. will enter a formal downturn within the next year continue to rise.

Megan Cassella, Barron’s

Financial markets rallied

In unscripted remarks, Fed Chair Jerome Powell indicated that interest rates had reached a neutral level. When rates are neutral, monetary policy is neither contractionary nor expansionary. Investors took Powell’s comment to mean the Fed might ease rates sooner rather than later, and markets rallied, wrote Economist Mohamed A. El-Erian in a Bloomberg opinion piece.

The S&P 500 soared 4.3% for the week and 9.1% in July, the best monthly advance since November 2020…Treasury yields dropped across the curve as well…Taken together, the equity and bond rallies helped loosen U.S. financial conditions.

Katherine Greifeld and Vildana Hajric, Bloomberg

While the rally was welcomed by investors, looser financial conditions are the opposite of what the Fed wants to achieve. It is trying to tighten financial conditions and reduce demand, and it appears the Fed has more work to do.

This Week in the Markets

Last week was a big one for monetary policy and economic data. The Federal Reserve raised interest rates 0.75%, with unanimous agreement that higher rates were required to bring inflation under control. In his press conference, Fed Chair Jerome Powell announced the Fed was becoming more data dependent. The market interpreted that statement to mean rate hikes would likely slow in the future, especially if inflation starts moving lower.

U.S. GDP shrank for the second consecutive quarter, contracting by 0.9%. Much of the economy remains strong, and services consumption continues to increase. Weakness in goods, inventories, housing, and government spending are contributing to signs the economy is slowing.

CTN 08-01-22 Image 1

The Personal Consumption Expenditures (PCE) Price Index confirmed the earlier Consumer Price Index report that inflation remains a challenge. PCE was up 1.0% as fuel prices added to pricing pressure in other sectors. Core PCE, which excludes food and energy, rose 0.6%.

Markets welcomed the idea the Fed may slow interest rate hikes sooner than expected. The S&P 500 gained last week to complete a nice rally for the month, and the global MSCI ACWI rebounded as well. The Bloomberg Aggregate Bond Index jumped slightly.

Are We in a Recession?

Many investors seem to have learned that two quarters of declining GDP means the country is in a recession. Yet, this definition isn’t totally accurate. There are far more factors the National Bureau of Economic Research (NBER) uses to determine whether there is a recession, but for much of the public, the two-negative-quarters definition seems to have stuck.

Like most rules, two quarters of economic decline isn’t a terrible test for a recession. The NBER defines recession as, “…a significant decline in economic activity that is spread across the economy and lasts for more than a few months.” Two quarters of declining GDP is usually significant, affects the broad economy, and lasts for more than a few months.

Reality indicates recessions are more complicated. None of the last three recessions matches the popular definition of two consecutive quarters of GDP growth. The 2001 recession had two nonconsecutive quarters of growth. The Great Financial Crisis had multiple negative growth quarters but started with a down and then up quarter. The 2020 COVID crisis had two consecutive negative quarters only because the very short recession overlapped the first and second quarters.

Sometimes quarterly economic patterns create short-term irregularities. The first quarter’s 1.6% decline in GDP had several. Personal consumption and investment remained robust. Declining federal spending from the end of pandemic-related support and weak exports, partly related to Russia’s invasion of Ukraine, caused the initial data release to show the economy shrunk in the first quarter. Those factors fail the test of the decline being spread across the economy. From a broader perspective, the vast majority of the economy remained strong. In fact, it was too strong, and the Federal Reserve was forced to embark on a program of rapid rate increases to tame inflationary pressures.

The weakness in the second quarter was broader than the first. Goods spending dropped 1.1%. Residential investment fell 3.7%, in line with our expectations that higher interest rates would pressure housing demand. Government spending also continued to decline as pandemic-related programs continued to wind down. Each of these areas experienced abnormal growth during the pandemic. People sought out goods to make social distancing less painful. The demand for housing rose rapidly as some people left big cities and others sought to expand their homes. Government programs supporting people displaced by the pandemic are no longer as necessary. Inventories also stopped increasing as rapidly as in previous quarters, pulling growth lower. What is bouncing back is services consumption, which increased 1.0% in the second quarter. Exports also bounced back from the temporary weakness in the first quarter.

Whether or not we have entered a recession is for others to debate but beyond the debate is the fact that the economy has slowed. Some of this pullback is necessary, as excess demand and lack of supply have caused unacceptable levels of inflation. Those inflationary pressures are quite broad. Wages rose 1.6% last quarter and are 5.7% higher than a year earlier. Core PCE inflation rose 0.6% last month. In order for inflation to move toward 2.0% per year, wage pressures will need to drop.

The recession argument wasn’t the only item that interested markets. The Fed also indicated it is seeing some signs of economic slowing. According to Fed Chair Jerome Powell, the recent rate hike has raised rates to a “moderately restrictive level” and the Fed will be more data dependent. Markets took this statement to mean the Fed is willing to slow interest rate increases if inflation starts moving lower.

We cannot predict if NBER will declare a recession and when they will determine that it began. We recognize that risks are higher than normal. The Fed would like to avoid a recession, but previous comments suggest it would be OK with “softish landing” in which the economy entered a shallow recession and then rebounded without the inflationary pressure. The broader point is the Fed recognizes its policy has tightened materially and it will adjust its future outlook and not keep raising rates and creating a far worse economic slowdown.

Company Sales and Profits Were Up in the Second Quarter

A perceived dovish tilt at the Fed wasn’t the only reason stocks rallied last week. It’s earnings season – that wonderful time when leaders of publicly traded companies tell investors how they performed during the last quarter and share expectations for the future. Investors review the information and use it to make decisions about whether to buy, sell or hold shares.

More than half of companies in the Standard & Poor’s 500 Index had reported by the end of last week. Earnings (profits) were better than expected for about three out of four of those companies. So far, companies in the energy and industrials sectors are the standouts for the second quarter. Energy sector earnings were up 290.3 percent and industrial sector earnings were up 25.7 percent, reported John Butters of FactSet. The consumer discretionary (down 17.9 percent) and financials (down 25.0 percent) sectors are the weakest performers, to date.

Revenue, which is the value of goods and services sold, was up more than 12 percent among the companies that have reported so far. Every sector of the index reported higher revenue for the second quarter with energy (up 66.4 percent), materials (up 16.1 percent), and real estate (up 14.7 percent) leading the way. The communication services (up 5.8 percent) and financials (up 2.5 percent) sectors lagged.

Despite worrisome signals from economic proxies like [a big box retailer] and [a shipping and supply chain management company], the earnings season as a whole has turned out to be brighter than expected...That’s fueling speculation that Corporate America will be able to weather the perfect storm of hot inflation, jumbo-sized rate hikes and dwindling growth.

Rita Nazareth, Bloomberg

While a significant number of companies have yet to report, blended second quarter earnings for companies in the Standard & Poor’s 500 index were up 6 percent.

Potential New Tax Provisions

New tax provisions have been included in recent legislation agreed upon by Senate Democrats. This legislation, known as the Inflation Reduction Act of 2022, also aims at lowering carbon emissions and reducing healthcare costs. Proposed tax changes in the bill include:

  • 15% corporate minimum tax to companies with profits greater than $1 billion
  • Enhanced tax enforcement efforts at the IRS
  • Revival of higher taxes on carried interest income
  • Removal or softening of international tax provisions

If passed, the deal is expected to raise about $739 billion in revenue, and is projected to reduce the budget deficit by roughly $300 billion in ten years. If the bill is approved in the Senate, it would then need to be passed in the House.

Did you Know? This Week in History

August 5, 1861: Abraham Lincoln Imposes First Federal Income Tax

On August 5, 1861, President Lincoln imposed the first federal income tax by signing the Revenue Act. With little cash as a result of the Civil War, Lincoln and Congress agreed to impose a 3 percent tax on annual incomes over $800.

The Revenue Act’s language was broadly written to define income as gain “derived from any kind of property, or from any professional trade, employment, or vocation carried on in the United States or elsewhere or from any source whatever.” According to the U.S. Treasury Department, the comparable minimum taxable income in 2003, after adjustments for inflation, would have been approximately $16,000.

Congress repealed Lincoln’s tax law in 1871, but in 1909 passed the 16th Amendment, which set in place the federal income-tax system used today. Congress ratified the 16th Amendment in 1913.

Weekly Focus

Life can only be understood backwards; but it must be lived forwards.

Soren Kierkegaard, Theologian and Philosopher

Let your dreams outgrow the shoes of your expectations

Ryūnosuke Satoro, Author and Poet